The History and Rationale Behind Using the 1% Rule When Pricing Your Properties for Sale
Many times when we receive properties or portfolios of properties for sale, we’ll get sales pricing that was set using the 1% Rule.
The 1% Rule of thumb compares the amount of rent being received on a property to the purchase price. If that price is 1% or greater than the rent, the seller feels comfortable setting that as a price.
For instance, if a property is receiving $1000/month in rent, a seller will use a sales price of $100,000.
However, the 1% Rule wasn’t made for that purpose.
The original goal of the 1% Rule was to determine if the rent would be greater to or, at worst, equal to the monthly mortgage payment. This helps to ensure that the property has a positive cash flow or at the very least, the property breaks even every month.
As it has been used over the years and taught by gurus, investors have taken to using this rule as a metric for determining the selling price of their investment property.
Using this method makes the price unusually high, which turns potential buyers off immediately.
So, what’s a better method of determining the price? Actual apples-to-apples comparable sales (comps).
When determining how to price a rental property, first look at the other rental properties that have sold in the market in the past 6 months to 1 year.
Many investors mistakenly look to retail sales comps on Zillow or similar sites to determine the value of their properties.
However, Zillow, Realtor.com, etc. will most often display the retail value of the properties- not the value as a rental or investment property.
To get retail prices, an investor would have to do retail work, which includes:
1. Clearing the property of any tenants
2. Making any necessary repairs to the property
3. Making upgrades to sell as a retail unit vs. a rental property
4. Put it on the market and pray it sells
Every investor wants the most that they can get for their properties, but comparing them to retail home prices is not the way to get there.
Investors can save loads of time and avoid headaches by using a pricing strategy that is in line with the market and focusing on reaching the type of buyers that are the best, most qualified to purchase their portfolios quickly and easily.
If you’d like help evaluating or selling your investment properties in and around the Metro Detroit area, please feel free to contact us!
Good luck and Happy investing!